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on Utility Models and Prospect Theory |
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Issue of 2021‒05‒17
twenty papers chosen by |
| By: | Levy, Matthew; Schiraldi, Pasquale |
| Abstract: | This paper studies the non-parametric identification of the discount factor and utility function in the class of dynamic discrete-continuous choice (DDCC) models. In contrast to the discrete-only model we show the discount factor is identified. Our results further highlight why Euler equation estimation approaches that ignore agents' discrete choices are inconsistent. We estimate utility and discount factors for a consumption- savings-retirement choice problem using the Panel Study of Income Dynamics (PSID). We show that the relative risk aversion parameter and the intertemporal elasticity of substitution are separately identified, and that the latter varies across agents due to the wealth-dependence of the surplus from the discrete choice. This surplus also implies that the value function may be locally convex in wealth, and we find that a simulated Universal Basic Income (UBI) policy counterintuitively benefits wealthier working households more than poorer ones due to this effect. |
| Date: | 2021–01 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:15719&r= |
| By: | Andreozzi, Luciano |
| Abstract: | Peters (2019) presents a new version of the St. Petersburg paradox that allegedly reveals a weakness of orthodox decision theory under uncertainty. I use a variant of Rabin (2000) calibration theorem to show that the new paradox only arises because the author implicitly assumes an unbounded utility function for money. I also assess the author's claim that orthodox decision theory is wrong in insisting on utility functions to be bounded and find it unconvincing. |
| Date: | 2021–05–05 |
| URL: | http://d.repec.org/n?u=RePEc:osf:socarx:axkfg&r= |
| By: | Bart Capéau; Liebrecht De Sadeleer; Sebastiaan Maes; André Decoster |
| Abstract: | Empirical welfare analyses often impose stringent parametric assumptions on individuals’ preferences and neglect unobserved preference heterogeneity. In this paper, we develop a framework to conduct individual and social welfare analysis for discrete choice that does not suffer from these drawbacks. We first adapt the broad class of individual welfare measures introduced by Fleurbaey (2009) to settings where individual choice is discrete. Allowing for unrestricted, unobserved preference heterogeneity, these measures become random variables. We then show that the distribution of these objects can be derived from choice probabilities, which can be estimated nonparametrically from cross-sectional data. In addition, we derive nonparametric results for the joint distribution of welfare and welfare differences, as well as for social welfare. The former is an important tool in determining whether those who benefit from a price change belong disproportionately to those who were initially well-off. An empirical application illustrates the methods. |
| Keywords: | discrete choice, nonparametric welfare analysis, individual welfare, social welfare, money metric utility, compensating variation, equivalent variation |
| Date: | 2020 |
| URL: | http://d.repec.org/n?u=RePEc:ete:ceswps:674666&r= |
| By: | Aluma Dembo; Shachar Kariv; Matthew Polisson; John K.-H. Quah |
| Abstract: | The Allais critique of expected utility theory (EUT) has led to the development of theories of choice under risk that relax the independence axiom, but which adhere to the conventional axioms of ordering and monotonicity. Unlike many existing laboratory experiments designed to test independence, our experiment systematically tests the entire set of axioms, providing much richer evidence against which EUT can be judged. Our within-subjects analysis is nonparametric, using only information about revealed preference relations in the individual-level data. For most subjects we find that departures from independence are statistically signifficant but minor relative to departures from ordering and/or monotonicity. |
| Date: | 2021–05–11 |
| URL: | http://d.repec.org/n?u=RePEc:bri:uobdis:21/745&r= |
| By: | Kazi Iqbal; Asad Islam; John List; Vy Nguyen |
| Abstract: | Whether, and to what extent, behavioral anomalies uncovered in the lab manifest themselves in the field remains of first order importance in finance and economics. We begin by examining behavior of retail traders/investors making investment decisions in constructed laboratory markets. Our results show that the behaviors of the traders are consistent with myopic loss aversion. We combine the lab results with a unique individual-level matched dataset on daily stock market transactions and portfolio positions over a two year period. We find that lab behaviors help to predict, but do not fully capture, the essential real-world trading analogs of retail traders. |
| Date: | 2021 |
| URL: | http://d.repec.org/n?u=RePEc:feb:framed:000730&r= |
| By: | Besner, Manfred |
| Abstract: | We introduce a new value for games with transferable utility, called grand dividends value. In the payoff calculation, the grand dividends value takes into account the worths of all subcoalitions of a player set. The concept of grand dividends, representing the surplus (which can also be non-positive) of the worth of the grand coalition over the worths of all coalitions that lack one player of the player set, is the initial point here. The grand dividends value satisfies many properties that we know from the Shapley value. Along with new axioms that have a similar correspondence to axioms that are also satisfied by the Shapley value, axiomatizations arise that have an analogous equivalent for the Shapley value, including the classics of Shapley and Young. |
| Keywords: | Cooperative game; (Harsanyi/Grand) Dividends; Shapley value; Grand dividends value |
| JEL: | C7 C71 |
| Date: | 2021–03–16 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:107615&r= |
| By: | Jacquet, Laurence; Lehmann, Etienne |
| Abstract: | We propose a new method, that we call an allocation perturbation, to derive the optimal nonlinear income tax schedules with multidimensional individual characteristics on which taxes cannot be conditioned. It is well established that, when individuals differ in terms of preferences on top of their skills, optimal marginal tax rates can be negative. In contrast, we show that with heterogeneous behavioral responses and skills, one has optimal positive marginal tax rates, under utilitarian preferences and maximin. |
| Keywords: | allocation perturbation; mechanism design; multidimensional screening problems; optimal taxation |
| Date: | 2021–01 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:15721&r= |
| By: | Francisco Roch (International Monetary Fund); Francisco Roldán (International Monetary Fund) |
| Abstract: | We analyze how concerns for model misspecification on the part of international lenders affect the desirability of issuing state-contingent debt instruments in a stan- dard sovereign default model à la Eaton and Gersovitz (1981). We show that for the commonly used threshold state-contingent bond structure (e.g., the GDP-linked bond issued by Argentina in 2005), the model with robustness generates ambiguity premia in bond spreads that can explain most of what the literature has labeled as novelty premium. While the government would be better off with this bond when facing rational expectations lenders, this additional source of premia leads to welfare losses when facing robust lenders. Finally, we characterize the optimal design of the state-contingent bond and show how it varies with the level of robustness. Our find- ings rationalize the little use of these instruments in practice and shed light on their optimal design. |
| Keywords: | Sovereign debt default state-contingent debt instruments robust control ambiguity premia |
| JEL: | E43 E44 F34 G12 H63 O16 |
| Date: | 2021–03 |
| URL: | http://d.repec.org/n?u=RePEc:aoz:wpaper:47&r= |
| By: | Lancia, Francesco; Russo, Alessia; Worrall, Tim S |
| Abstract: | Optimal intergenerational insurance is examined in a stochastic overlapping generations endowment economy with limited enforcement of risk-sharing transfers. Transfers are chosen by a benevolent planner who maximizes the expected discounted utility of all generations while respecting the participation constraint of each generation. We show that the optimal sustainable intergenerational insurance is history dependent. The risk from a shock is unevenly spread into the future, generating heteroscedasticity and autocorrelation of consumption even in the long run. The optimum can be interpreted as a social security scheme characterized by a minimum welfare entitlement for the old and state-contingent entitlement thresholds. |
| Keywords: | Intergenerational insurance; Limited Commitment; Risk Sharing; stochastic overlapping generations |
| JEL: | D64 E21 H55 |
| Date: | 2020–12 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:15540&r= |
| By: | Hernán Bejarano (Centro de Investigación y Docencia en Economía de México/Chapman University); Brice Corgnet (EM Lyon Business School); Joaquín Gómez-Miñambres (Lafayette College) |
| Abstract: | We extend Akerlof’s (1982) gift-exchange model to the case in which reference wages respond to changes in the work environment such as those related to unemployment benefits or workers’ productivity levels. Our model shows that these changes spur disagreements between workers and employers regarding the value of the reference wage. These disagreements tend to weaken the gift- exchange relationship thus reducing production levels and wages. We find support for these predictions in a controlled, yet realistic, workplace environment. Our work also sheds light on several stylized facts regarding employment relationships such as the increased intensity of labor conflicts when economic conditions are unstable. |
| Keywords: | Gift-exchange incentives self-serving biases reference-dependent utility laboratory experiments labor conflicts |
| JEL: | C92 D23 M54 |
| Date: | 2021–04 |
| URL: | http://d.repec.org/n?u=RePEc:aoz:wpaper:56&r= |
| By: | Stephan Leitner |
| Abstract: | This paper introduces a model of a stylized organization that is comprised of several departments that autonomously allocate tasks. To do so, the departments either take short-sighted decisions that immediately maximize their utility or take long-sighted decisions that aim at minimizing the interdependencies between tasks. The organization guides the departments' behavior by either an individualistic, a balanced, or an altruistic linear incentive scheme. Even if tasks are perfectly decomposable, altruistic incentive schemes are preferred over individualistic incentive schemes since they substantially increase the organization's performance. Interestingly, if altruistic incentive schemes are effective, short-sighted decisions appear favorable since they do not only increase performance in the short run but also result in significantly higher performances in the long run. |
| Date: | 2021–05 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2105.04514&r= |
| By: | Klarizze Anne Martin Puzon; Rachel M. Gisselquist |
| Abstract: | Using illustrations from research on inequality, this paper offers evidence on the strengths of 'behavioural synthesis', i.e. the reconciliation between neoclassical and behavioural economics. We compare how theoretical models of absolute and relative inequality have evolved from assumptions of income maximization to status-seeking competition, and to altruism. We emphasize the relevance of experiments in testing competing theories and mitigating empirical shortcomings. We conclude that methodological pluralism, i.e. |
| Keywords: | Inequality, Behavioral economics, Behaviour, Methodology (Economics) |
| Date: | 2021 |
| URL: | http://d.repec.org/n?u=RePEc:unu:wpaper:wp-2021-76&r= |
| By: | Kuvshinov, Dmitry; Zimmermann, Kaspar |
| Abstract: | This paper estimates the expected return on equity and housing for 17 advanced economies between years 1870 and 2015. We show that the expected risky return has been in steady decline, but its trend is markedly different to that in the safe rate. As a consequence, the ex ante risk premium exhibits large secular movements, and risk premia and safe rates are strongly negatively correlated. Our findings suggest that time-varying risk appetite is a key driver of expected risky and safe returns - not only in the short, but also in the long run. |
| Keywords: | expected returns; long-run trends; real interest rates; return predictability; risk premia |
| JEL: | E43 E44 G12 G15 N20 |
| Date: | 2020–12 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:15610&r= |
| By: | Dong, Xueqi; Liu, Shuo Li |
| Abstract: | This paper studies how investment can be influenced by common tax and monetary policies, where investment is measured by the proportion of an investor’ wealth invested in the asset that pays a random return. We further prove that all risk- uncertainty averse individuals will increase investments if and only if a type of proportional tax with full loss offset (Domar and Musgrave 1944, QJE) is imposed. This result holds: 1. under ambiguity, that is when the probability distribution of an as- set’s return is unknown; 2. when borrowing in the safe asset is allowed. |
| Keywords: | Proportional Tax with Full Loss Offset, Ambiguity, Portfolio Choice |
| JEL: | D80 |
| Date: | 2021–05 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:107668&r= |
| By: | Rahul Deb; Ludovic Renou |
| Abstract: | A researcher observes a finite sequence of choices made by multiple agents in a binary-state environment. Agents maximize expected utilities that depend on their chosen alternative and the unknown underlying state. Agents learn about the time-varying state from the same information and their actions change because of the evolving common belief. The researcher does not observe agents' preferences, the prior, the common information and the stochastic process for the state. We characterize the set of choices that are rationalized by this model and generalize the information environments to allow for private information. We discuss the implications of our results for uncovering discrimination and committee decision making. |
| Date: | 2021–05 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2105.03683&r= |
| By: | Hernán Bejarano (Centro de Investigación y Docencia en Economía de México/Chapman University); Joris Gillet (Middlesex University); Ismael Rodríguez-Lara (Chapman University/Universidad de Granada) |
| Abstract: | We investigate experimentally the effect of a negative endowment shock in a trust game to assess whether different causes of inequality have different effects on trust and trustworthiness. In our trust game there may be inequality in favor of the second mover and this may (or may not) be the result of a negative random shock (i.e., the outcome of a die roll) that decreases the endowment of the first-mover. Our findings suggest that inequality leads to differences in behavior. First-movers send more of their endowment and second-movers return more when there is inequality. However, we do not find support for the hypothesisthat the cause of the inequality matters. Behavior after the occurrence of a random shock is not significantly different from the behavior when the inequality exists from the outset. Our results highlight that we have to be cautious when interpreting the effects on trust and trustworthiness of negative random shocks that occur in the field (e.g., natural disasters). Our results suggest that these effects are largely driven by the inequality caused by the shock and not by any of the additional characteristics of the shock like saliency or uncertainty. |
| Keywords: | Trust game endowment heterogeneity random shocks inequality aversion experimental economics |
| JEL: | C91 D02 D03 D69 |
| Date: | 2021–04 |
| URL: | http://d.repec.org/n?u=RePEc:aoz:wpaper:50&r= |
| By: | Wang, Ao (University of Warwick) |
| Abstract: | Applied researchers most often estimate the demand for dierentiated products assuming that at most one item can be purchased. Yet simultaneous multiple purchases are pervasive. Ignoring the interdependence among multiple purchases can lead to erroneous counterfactuals, in particular, because complementarities are ruled out. I consider the identification and estimation of a random coefficient discrete choice model of bundles, namely sets of products, when only product-level market shares are available. This last feature arises when only aggregate purchases of products, as opposed to individual purchases of bundles, are available, a very common phenomenon in practice. Following the classical approach with aggregate data, I consider a two-step method. First, using a novel inversion result in which demand can exhibit Hicksian complementarity, I recover the mean utilities of products from product-level market shares. Second, to infer the structural parameters from the mean utilities while dealing with price endogeneity, I use instrumental variables. I propose a practically useful GMM estimator whose implementation is straightforward, essentially as a standard BLP estimator. Finally, I estimate the demand for Ready-To-Eat (RTE) cereals and milk in the US. The demand estimates suggest that RTE cereals and milk are overall complementary and the synergy in consumption crucially depends on their characteristics. Ignoring such complementarities results in misleading counterfactuals. |
| Date: | 2021 |
| URL: | http://d.repec.org/n?u=RePEc:wrk:warwec:1351&r= |
| By: | Bochet, Olivier; Faure, Mathieu; Long, Yan; Zenou, Yves |
| Abstract: | Agents compete for the same resources and are only aware of their direct neighbors in a network. We propose a new equilibrium concept, referred to as peer-consistent equilibrium (PCE). In a PCE, each agent chooses an effort level that maximizes her subjective perceived utility and the effort levels of all individuals in the network need to be consistent. We develop an algorithm that breaks the network into communities. We use this decomposition to completely characterize peer-consistent equilibria by identifying which sets of agents can be active in equilibrium. An agent is active if she either belongs to a strong community or if few agents are aware of her existence. We show that there is a unique stable PCE. We provide a microfoundation of eigenvector centrality, since, in any stable PCE, agents' effort levels are proportional to their eigenvector centrality in the network. |
| Keywords: | eigenvector centrality; policies; Social Networks |
| JEL: | C72 D85 |
| Date: | 2020–12 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:15582&r= |
| By: | Pablo Brañas-Garza (Universidad Loyola); Diego Jorrat (Universidad Loyola); Antonio Espín (Universidad de Granada); Angel Sánchez (Universidad Carlos III de Madrid) |
| Abstract: | The use of hypothetical instead of real decision-making incentives remains under debate after decades of economic experiments. Standard incentivized experiments involve substantial monetary costs due to participants' earnings and often logistic costs as well. In time preferences experiments, which involve future payments, real payments are particularly problematic. Since immediate rewards frequently have lower transaction costs than delayed rewards in experimental tasks, among other issues, (quasi)hyperbolic functional forms cannot be accurately estimated. What if hypothetical payments provide accurate data which, moreover, avoid transaction cost problems? In this paper, we test whether the use of hypothetical - versus real - payments affects the elicitation of short-term and long-term discounting in a standard multiple price list task. One-out-of-ten participants probabilistic payment schemes are also considered. We analyze data from three studies: a lab experiment in Spain, a well-powered field experiment in Nigeria, and an online extension focused on probabilistic payments. Our results indicate that paid and hypothetical time preferences are mostly the same and, therefore, that hypothetical rewards are a good alternative to real rewards. However, our data suggest that probabilistic payments are not. |
| Keywords: | Time preferences hypothetical vs real payoffs lab field online experiments BRIS |
| JEL: | C91 C93 |
| Date: | 2021–04 |
| URL: | http://d.repec.org/n?u=RePEc:aoz:wpaper:54&r= |
| By: | Caroline Dauenhauer (HHL Leipzig Graduate School of Management); Jens K. Perret (International School of Management) |
| Abstract: | Low involvement goods per definition do not require the customer to invest a significant amount of will-power into the purchasing decision. Thus, buying decisions in this context are primarily driven by the intuitive mind and relevant decision heuristics. This study focuses on the anchor and the framing heuristic, their combined effect on the willingness-to-buy of low involvement goods and especially their interaction effect. It is established that of the two heuristics considered, the framing effect is the more relevant with an impact roughly 2.5 times the size of the anchor effect. An interaction effect between the two heuristics exists even though it is only weakly significant and only marginally impacts the willingness-to-buy, reporting an effect size of one fifth of the anchor effect. Although limited in its scope the weakly significant interaction effect shows that in certain retail environments price reduction have a more pronounced effect than in others. The study provides relevant insights from a theoretical academic perspective and offers advice to marketing practioners, in particular advertising experts. |
| Keywords: | Purchasing; Behavior; Price Anchor; Framing; Prospect Theory; Discounter |
| JEL: | C21 D91 M31 |
| Date: | 2021–04 |
| URL: | http://d.repec.org/n?u=RePEc:bwu:eiiwdp:disbei299&r= |